«By Hoda Jaber I.D: 80108 Dissertation MSc Finance & Banking Faculty of Finance & Banking Dissertation Supervisor Dr. Elango Rengasamy Feb-2012 Contents ...»
Impact of the Global Financial Crisis on GCCUAE's Banking Sector
MSc Finance & Banking
Faculty of Finance & Banking
Dr. Elango Rengasamy
The Global Financial Crisis…………………………………...5
The Impact of the Crisis on GCC Countries…………………..7 Exposure of GCC banks…………………………………...….9 Brief History of UAE Banking Sector………………………..12 Dubai Debt Structure…………………………...………...…..14 Impact of the Crisis on Dubai & its Banking Sector……….…19 NBAD Case…………………...…..…...………...………...…36 GCC Islamic Banks & the Crisis………………………….....41 Corporate Governance in the GCC Banking Sector…………43 Conclusion…………………………...………...………...…..53 References…………………………...………...………...…..54 Abstract The rationale behind this paper is to inspect the impact of the global financial crisis on GCC countries, UAE in particular & its banking sector. To assess the extent of that effect, this paper provides some comparison before & after the crises. Additionally, it examines the challenges & recommendations.
Whilst for various GCC the effects of the crisis have been considered to be mild compared to the rest of the world, its impact had been ruthless in some countries, including UAE. A lot of GCC countries have made an gigantic effort in strengthening their policy frameworks and sturdiness, thought-provoking a healthy economic growth, improving the sovereign wealth fund, foreign reserve, financial systems, and the account balance. But a lot are still considered being highly susceptible to a deep global downturn that is so very well linked to oil prices. This paper provides policy advice on how best to address the impact of the crisis on GCC countries, UAE banking sector specifically, and describes suitable measures & policies that should be adopted. It is crucial to set up managed financing facilities to help out sms's, the realestate sector, the bank operations and industrial sectors, while making efforts to maintain and catalyze additional resources, if needed, from sovereign wealth fund and government bond issues.
Methodology This paper is a review of the published materials focusing on three distinct areas: the Impact of the global financial crisis on GCC, causes behind Dubai crisis and subprime lending, and its impacts on the economy of the UAE banking sector. Research was based on published articles, journals, UAE central bank data, in addition, other date were collected from formal authorities like IMF, BIS, & GCC central banks.
The findings divulge that the Dubai Crisis had a momentous responsibility on the UAE mortgage market and had impacts on the international stock markets. The findings also clarify the reasons and latent solutions to Dubai’s debt and Global financial crisis connotation and implications.
The Global Financial Crisis
The subprime mortgage crisis which started in the US in 2007 has developed into a packed international financial crisis which had harsh consequences on the GCC countries and their growth. All of the GCC countries have considerable assets in the US but most prominently, they have been hit by the increased costs of funding and liquidity problems in the middle of the crisis. After showing pliability in 2007 and remaining moderately unaffected by the global subprime turmoil in 2007, the GCC equity markets have endured much more than the markets in the US and other developed markets. Saudi Arabia and the UAE (Dubai), indices have declined more than 40 percent since the beginning of 2008.
Fuelled by admittance to very cheap credit, a housing bubble developed in the US from early 2001. Outstanding credit quantities increased profoundly. The Fed followed a low interest rate policy, whereas the banks marketed risky mortgage products forcefully and had increased the lending to subprime customers at reduced risk premiums. Home owners in turn got used to rising house prices and increased borrowing against their house values without any regard for the obscure risks. Finally, a growing securitization industry and the practice of putting assets in off balance Special Investment Vehicles (SIV) had led to the bubble, as rating agencies were contented and gave unrealistic ratings based on impractical model calculations. The first fractures appeared in 2006, with home prices declining in some segments and foreclosures increasing. The real eruption of the crisis began in March 2007 when more than 25 subprime lenders in the US declared bankruptcy, announced momentous losses, erupted themselves up for sale.
The major cause or the driving factor that had started the global financial crisis is the incapability of homeowners to make their mortgage payments, due chiefly to adjustable-rate mortgages resetting, borrowers overextending, greedy lending, speculation and overbuilding during the boom period, risky mortgage products, high personal and corporate debt levels, financial products that dispersed and possibly concealed the risk of mortgage default, monetary policy, international trade imbalances, and government regulation (Emmons 2008).
The origins of the 2007 financial crisis, which was the sub-prime crisis in the US, be related to the development of financial products such as residential Mortgage Backed Securities, Collateralized Mortgage/Debt Obligations and Credit Default Swaps (CDS) which were subjected to modest or no regulatory inspection for their systemic risk impact. So the financial crisis erupted in high-risk loans because numerous banks which are specialized in real estate sector gave a lot of loans to hundreds of thousands of citizens with limited income, with complete ignorance to the risk.
One of the strong causes of the global crisis was the collapse of the Lehman Brothers, one of the biggest financial institutions in the US, and its filing for bankruptcy on September 15, 2008 made an enormous loss of confidence in the credit and stock markets. In fact, these directed to an absolute blackout of the credit markets.
However, the housing bubble was not defiantly not accidental, and it was accompanied by a credit mortgage bang, unwarranted leverage in the financial sector which is one of the main causes of global financial crisis, an era of low interest rates and easy money, multifaceted securitization of mortgage backed securities fuelled up by credit ratings boom, and many other derived factors.
The Impact of the Crisis on GCC Countries
Subsequent September 2008, stock prices in the GCC have decreased hurriedly, so was the case with other developing countries. GCC total stock market capitalization chop down by about $320 billion from September 10 to October 15, 2008 which is almost 38% of the joint GCC GDP for 2007. With rising dearth of global liquidity, the international financial institutions and the banks became more risk averse and the cost of borrowing at GCC augmented piercingly. Also, de-leveraging by foreign banks raised the cost and condensed the accessibility of liquidity dipping the demand for GCC assets.
GCC banks in general were moderately less impacted by the crisis than other banks of other countries, with the exception to a few banks in typically the UAE & Qatar. The profusion of financial resources for GCC, in addition to the preliminary macro intervention policies taken by their governments, ought to aid to mitigate the adverse impact of the current global financial crisis.
In addition, GCC banks were not as a great deal directly exposed to the securitized and structured financial products and thus were generally less impacted by the global financial crisis. Some of the mainly perceptible effects of the global financial crisis so far have not been caused so a great deal by direct exposure to structured noxious assets but in indirect form, as the GCC countries and their infrastructure and realestate project finance markets have been affected by the growing costs of borrowing and the diminishing number of large credit finance banks. Hardly any GCC banks only have admitted in public their true exposure to Lehman Brother and the AIG fallout.
These types of exposures might have been in the form of bank bonds, structured investment products and derivative CDS guaranteed by companies like AIG or a bankrupt US investment bank. Nevertheless, bulky percentage of GCC assets is not managed by banks but is managed by Sovereign Wealth Funds, such as Abu Dhabi Investment Authority (ADIA) or Kuwait Investment Authority (KIA). The kind of investment in SWFs comprise a broad range of securities, however published data about the type and compositions of the assets is not accessible and most sources report estimates only. While the direct subprime exposure of GCC banks has been narrowed, the genuine nuisance for the GCC banks lies in the indirect exposure to enlarged costs of funding amidst maturity disparities and credit exposure to local consumer, project and real-estate financing.
Earlier to the financial crisis, inflation was considered high and interest rates were low which led to huge negative real interest rates in the GCC countries and did not offer an enticement to save. There was a big deterioration in Dubai issued bonds which comprised a big share of the GCC bond market, as Dubai had borrowed expansively to finance its infrastructure and its development projects. There was also a very high value of credit default swap, in which Nakheel for instance, traded at nearly 2000 as of October 10, 2008 whilst the CDS for Saudi Arabia traded at 125. It is quite palpable that the CDS market in Dubai showed an amplified rollover risk, because the bulk of long term project funding have been financed with short-term funds, this maturity disparity placed further pressures in the existing tight capital markets.
The bond market for the GCC countries started to degenerate starting in 2007 with major projects in UAE and Bahrain had to be postponed because of critical market situations The loan market in the GCC countries was harshly stressed just before the end of 2008 and began to ease a little in March 2009 as of several GCC government interventions and the issuance of SWF Bonds and liquidity injections. On the other hand, most foreign banks are still indisposed to expand their commitments as they face liquidity constraints in their home countries. Project cancelations, postponements and amendments had amplified in the fourth quarter of 2008 and first quarter of 2009.
An expected $39 billion in debt for the GCC had to be repaid or refinanced in 2009, and half of which came from the UAE single-handedly. UAE central bank was one of the first banks in the GCC to grant guarantee for bank deposits similarly to western banks in the US and Europe. In addition, GCC central banks, in the efforts to ease the credit crunch, injected liquidity as in the case of UAE, which provided Dh50 billion short-term facility to banks followed by a supplementary injection of Dh 70 billion on October 15 2008, ( UAE Central Bank, 2008).
Exposure of GCC Banks
With an anticipated $1.8-2 trillion in foreign assets by the end of 2008, of which about 60 percent were held in US dollar, the GCC countries must evidently be troubled about the asset depreciation.
Abu Dhabi Commercial Bank has announced an exposure of $272 million and has sued Morgan Stanley and other banks for erroneous recommendation in the case of an inopportune SIV deal. Bahrain’s Arab Banking Corporation had to handle writedowns of $1.2 billion; Kuwait-based Gulf Investment Corporation has announced write-downs of $246 million at the end of 2007 and was expected to add an additional $200 million; also Bahrain’s Gulf International Bank was downgraded by Moody’s because of the bank’s holdings of US mortgage-backed securities. Although S&P believed that fundamentally Gulf subprime exposures are limited, it considered that banks may be hiding related losses. Among others, Qatar Insurance Company has also been connected with possible subprime losses.
The UAE Central Bank has asked UAE banks to declare their exposure to Lehman in the middle of the bankruptcy of the US banks, but not surprisingly, no public announcement by banks about auxiliary exposures has resulted from this measure. In mid September 2008, the UAE’s Central Bank Governor Nasser Al-Suwaidi ruled out a systematic risk exposure of the UAE in the framework of the financial crisis in the US. The Saudi Arabian Monetary Authority (SAMA) was fast to proclaim that no solemn Lehman exposure of Saudi banks subsist, amidst somber doubts that with time passing, such exposure may well surface or in fact may be already there but is not being acknowledged. On the other hand, the Central Bank of Bahrain approved on September 17, 2008 in an interview with MEED that banks in Bahrain might be hauling exposure to Lehman Brothers but did not give any further details. Tawuniyya, the leading Saudi insurance company, has lost about two thirds of its worth since January 2008, sternly underperforming in an already shabby Saudi stock market.
All in all till now the announced subprime exposure of GCC banks of about $2.7 billion seems to be minute compared to over than $500 billion in Europe and the US.
Fraction of this may be attributable to a lack of transparency with more exposure expected to surface over time, for sure; on the other hand, subjective evidence suggests that GCC banks have been moderately conservative compared to their American and European peers. In many cases, the investment criterion of banks did not permit the purchase of non-investment grade bonds or complex structured products and infrequent lack of sophistication may have proven to be valuable for some banks, now that such products are considered factually discredited.
Source: GCC Banks: On the Road to Maturity, AT Kearney, 2010 Foreign claims on GCC as of June.2011 by nationality of reporting banks, USD billion Brief History of the UAE Banking Sector The UAE banking sector started to witness valid expansion when the exploration of oil reserves started in the early 1960s. At the time, new banks were entering the country. The rulers of the UAE stepped in as the regulators in 1975 and banned the opening of any new foreign banks in the UAE for a two-year period. In 1980 the Federal Currency Board had changed and became the Central Bank of the UAE and put a new law in place which empowered the Central Bank's functions. In 1981, the licensing of new banks was allowed again and a lot of banks throughout that period were entering the market. However, in the mid-1980s, several banks failed due to disregard and fraud, as a result of collapsing oil prices and a real estate collide resulted in high non-performing loan levels. In 1984, the Central Bank of the UAE decided, for the second time, that it would not bestow new branch licenses, and already operating foreign bank branches were limited to only eight branches each.
The Central Bank also took quite a lot of actions in the 1980s to strengthen the banking formation through expanding audits and inspections, rising bank-reporting requirements, creating a computerized loan risk subdivision, and setting minimum capital requirements. In 1998, the Central Bank established a particular unit to just monitor the money-laundering activities and inspect any suspicious deals. Till date, the UAE central bank is doing its best to control UAE's banking sector, specially after the crisis.
In 2006, UAE outperformed most among its peers in the MENA region in terms of loan and deposit growth. The UAE’s banking sector entirety assets reached AED860 million (US$234.3 billion) in 2006, creating the leading asset base in the region, exceeding Saudi Arabia (which was beforehand the largest asset base) having SAR861.1 billion (US$230 billion) in banking assets in 2006. In addition, the UAE had a higher than MENA average loan/deposit, loan/asset and loan/GDP ratios in 2006.